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Tuesday, March 8, 2011

Calculating Your Test Equipment's "Total Cost of Ownership"

This blog post provides a summary of an awesome paper I just read entitled The Real "Total Cost of Ownership" of Your Equipment by Duane Lowenstein and Bill Lycette (refer to the link at the end to read the paper). We will discuss how to calculate the total cost of your test equipment over time using the Total Cost of Ownership (TCO) model. The TCO is the total cost to own and operate a piece of equipment over its useful life. The TCO model presented in the paper structures operating expenses in the following manner:

1.) Ca: Price you payed for the test equipment.
2.) Cpm: The major portion of this cost is calibration. Two pieces of test equipment X and Y have a similar price tag but if X has an 18 month cal cycle and Y has a 3 year cal cycle then chances are Y will have a much lower cost over time. Also cal turn around time must be considered because until it is cal'd you can not use it. In my youth I did calibration and I can tell you from personnel experience that cal technicians remember model numbers that typically pass cal (referred to as cherries) and model numbers that typically fail cal (I am not going to say what they were referred to as). Cherries spend a lot less time on the "awaiting cal" shelf compared to model numbers that are known to fail and often need work.
3.) Cr: I will quote this part from the paper "Repairs, sometimes also called as corrective maintenance actions, generally refer to unplanned downing events such as equipment failure. For the purposes of this TCO model, corrective maintenance costs are represented by the cost to perform the repair, re-calibrate after the repair, remove/ship/re-install (logistics), and verify performance of the equipment. The cost to perform the repair can be represented by either a contracted repair agreement or, if the owner wishes, to “self-insure” on a Per Incident (P.I.) basis. Annual P.I. repair expenses are modeled as the expected annual value calculated by multiplying the P.I. cost times the probability of failure occurring over a one year period. While at first glance it may appear that a P.I. strategy is the lower cost option, one must also consider that a repair contract usually results in a lower repair TAT and therefore lower downtime."
4.) Cdm: I will quote this part from the paper "A downtime cost penalty must be applied to recognize the fact that the equipment was unavailable for use by the owner. This is accomplished by applying a cost driver variable, such as a weekly rental rate proxy, to the cost equation such that: Cost of Unavailability = (purchase price) x (rental rate proxy) x (repair TAT)"
5.) Ctr: This is sometimes referred to as product migration. It cover the need to update a piece of test equipment due to a need for increased measurement capabilities or measurement speed. It can get costly in test system when you consider code compatibility. These are one-time expenses that should be amortized over the test equipment that gets the refresh.
6.) Cte: Cost of any training required to operate, calibrate (if using in house lab), learn software, or write software for the test equipment.
7.) Crv: This is what the equipment is worth after you are done with it, could be positive or negative value. Of course higher quality test equipment with high reliability is going to fetch a higher price on the used market.
8.) Cf: Costs like electricity to power equipment, air conditioning to cool equipment, and space to house equipment.
9.) Co: This may include things like cables, connectors, or tools. It could also be used to catch any costs that may be specific to your exact testing needs.

The following is an example using the TCO model that clearly shows why the initial purchase price should not be the only factor considered when calculating the cost of a piece of test equipment. The example is quoted from the paper:
Product A is a higher cost test solution. At a price tag of $100,000, it offers higher measurement speed, longer cal intervals, superior reliability and better code compatibility. Because of its superior reliability, the user of Product A is comfortable holding less test capacity in reserve to guard against unplanned downing events such as equipment failure (captured as Downtime Mitigation in the table below). Supplier of Product A also provides on-site repair, a service that supplier of Product B cannot offer. The on-site service contract commands a price premium, however repair TAT is substantially reduced as compared with a return-to depot contract. Product B cannot match many of these ownership factors, however the purchase price for the product is 25% less. Industry views Product A as having higher intrinsic value and this is borne out by a higher resale value on the open market. Table I shows the summary of key differences in ownership factors.

The test equipment is operated 96 hours per week in a manufacturing environment. Useful life of the equipment is eight years and the depreciation method is five year straight line. A downtime cost penalty (4% of purchase price per week) is assigned to reflect the cost of the equipment being unavailable during repair, calibration or other preventive maintenance actions. Cost of test software development to ensure code compatibility is amortized across an installed base of 20 test systems. A TCO analysis is performed and the lifetime cost to own and operate Product A is $137,000 compared with a lifetime cost of $160,000 for Product B.

Another thing to consider is Product A is also faster so you can test the same amount of DUTs in less time compared to product B. This leads to a lower cost of test per DUT which directly impacts (in a good way) profit return per unit sold. For more details on TCO refer to the link below to access the full paper.

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